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Valuations Schmaluations – Chasing the Wrong Thing

You can’t escape Facebook news these days. Next week’s nationwide premiere of ‘The Social Network’ – a highly fictionalized account of the company’s founding – has focused the lens of the media squarely on the social networking giant. I’ve read through in-depth profiles on founder Mark Zuckerberg, leaked log files and IMs from his days at Harvard, and a few financial projections on Facebook’s worth.

While all of those pieces were at least mildly interesting, the last topic was the one that most grabbed my attention. How much is Facebook worth? It depends who you ask.

Those lofty numbers certainly jump off the page, but do they make Facebook a successful company?

In the technology world, success can sometimes be a hard thing to define. Profit has always been the best measuring stick for true success. After all, the reason almost all companies get into business is to make money. It seems simple enough. However, today the business model for most startups looks something like this: build/create something awesome, get users, figure out how to monetize or sell to the highest bidder.

Monetization is often low on the priority list and success is too often measured in users, followers, or fans, not dollars.

Certainly, it takes time to properly monetize a service on the web. Amazon, for instance, didn’t start turning a profit until 2001, 6 years after they launched. The wait was well worth it for them.

But was Amazon a ‘success’ in, say, 1998? Not at all.

In Facebook’s case, they are pulling in revenue. Since they are a private company there’s no way to know all the numbers, but reports have projected that they are making over $1 billion in ad revenue.

Don’t let that number fool you either though. Facebook has taken almost a billion dollars in venture capital alone. And 500 million users requires an awful lot of overhead.

As David Heinemeier Hansson wrote: “Facebook has been around for seven years. It has 500 million users. If you can’t figure out how to make money off half a billion people in seven years, I’m going to go out on a limb and say you’re unlikely to ever do.”

So while the wild popularity of companies like Facebook and the billions that they are said to be worth are nice, the numbers aren’t real. Headline-grabbing valuations are not indicators of success at all. They are just ‘Monopoly money.’ Somebody can say your company is worth $1B dollars but unless you are selling for that figure or bringing in that amount in profits it is all just fantasy money.

If you step away from the online world for a second, it helps to clarify how ridiculous some of these valuations are.

Let’s look at an overly simplified example of two coffee shops:

Coffee Shop A – 800 people per day with an average of $0.20 profit per customer

Coffee Shop B – 300 people per day with an average of $0.75 profit per customer

It’s clear to anybody who can make a couple quick calculations that Coffee Shop B is the more profitable and more successful company. Coffee Shop A might be more popular and maybe it has really cool events and a great location, but it isn’t monetizing nearly as well as Coffee Shop B.

If these were two Internet startups, things would end up backwards. Coffee Shop A would get all the buzz. You’d read about it on Techcrunch. All the ‘cool kids’ would be talking about it. Some ‘expert’ would compare the two and choose the hip, more popular one. Then the expert would come up with a ridiculous method of assigning a dollar value to each of the users. Projections would be made and suddenly Coffee Shop A is a billion dollar company. This is why you read headlines like “A $65 billion dollar value for MySpace?” (2007).

An inflated valuation figure is not ‘success.’ A million users is not ‘success.’ They may end up as by-products of success but if you are chasing after followers instead of dollars, you are doing something terribly wrong.

byTrevin Shirey on September 24, 2010
Trevin Shirey is the Sr. Business Development Manager at WebpageFX

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http://www.johntibbsmusic.com John Tibbs

Great article, Trevin. It’s a lot like the artists signed to a Major label who sell 100,000 units and don’t make a dime, while the Independent artist sales 10,000 units and makes bank. Sometimes less is more.

http://www.webpagefx.com/blog Trevin Shirey

Hey John! Good to hear from you!

I think that’s a great comparison. Too many people become obsessed with growth at all costs whether it is business or music or anything. Being small is a good thing. You are a lot more agile and able to make the smart decisions, not what some investor or record label exec wants.

I really like the phrase “Less is less” because “Less is more” implies that more is better 🙂

http://sarahsheriff.com Sarah Sheriff

Very well written – I’ve often wondered exactly where those figures come from, as it seemed they were meaningless for the very reasons you outlined.

The coffee shop example is a great way to put things into perspective. Thanks for taking the time to share this with everyone!

http://www.webpagefx.com/blog Trevin Shirey

Hey Sarah!

Thanks for the kind words and for the retweet 🙂

http://www.mudbrickcreative.com Paul Benninghove

The one thing you article doesn’t take into account is that in many cases with a software developer the end goal is not to develop something that monetizes for them, but build a platform with a million users and then sell it to someone who wants to take a stab at monetizing it. Not always a success at going that route but more often than not the way the cash happens.

Good local example is CoTweet. Get funding, continue development, get purchased.

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